Business Cycle Synchronisation and the Prospects of a Monetary Union in the East African Community

Abstract

Forming a monetary union has been a long-term objective of the East African Community. In this stage, member states adopt a common  monetary policy that entails a use of a single currency purposively to cushion members against potential macroeconomic and structural  shocks. However, the adoption of the common monetary policy is feasible only for countries experiencing similar macroeconomic shocks.  In view of the above, the present study examines the potential for a successful East African Monetary Union. The study collected  secondary data from the EAC facts and figures reports, and the African Development Bank database for the period between 2000 and  2013. The study examined a range of real and nominal variables whose data was obtained within this range. These include bilateral trade,  openness to trade, trade specialization and economic specialization as well as exchange rate, budget deficit, financial openness,  monetary policy, current account balance, and gross national savings. Correlation analysis was used to determine the degree of degree of convergence among EAC member countries, whereas the Ordinary Least Square based Extreme Bound Testing was used to examine  the determinants of the convergence. The findings indicate that in the pre-integration period, each member of the EAC had uncorrelated  business cycle movement. In the postintegration period, however, member states seemed to have experienced some convergence. The  convergence is attributable to common monetary policy, fluctuation in exchange rate, and financial openness. Nonetheless, the degree to  which macroeconomic shocks are synchronised is still low. This implies that the adoption of a single monetary policy is still not  feasible in the near future. To make the monetary union more feasible, the EAC member states should continue promoting intra-regional trade, which is anchored in a rule-based framework and political commitment.